Course 410: Distressed Stocks
What Went Wrong?
In this course
1 Introduction
2 What Went Wrong?
3 How Bad Is It?
4 Is the Stock Despised?
5 How Cheap Is It?
6 Conclusion: Putting It All Together

Like an insurance adjuster, our first mission is to determine the cause of distress. The answer usually boils down to operating weakness or financial exhaustion. And the path to recovery is very different in each case. It may be that a company in financial distress is an attractive business but has collapsed under the weight of a poorly designed capital structure. Think of the leveraged-buyout era. In its 1989 buyout, RJR Nabisco's long-term debt increased from $5.5 billion to $25.2 billion. The tobacco and snack-food giant was earning a healthy operating profit, but interest expenses absorbed it all. In 1989 and 1990, the company lost a combined $1.6 billion. RJR later reduced its debt and returned to profitability, eventually selling and spinning off its tobacco businesses in 1999. RJR's business was never the problem. There is plenty of money to be made in cigarettes and Chips Ahoy cookies. But a debt-heavy capital structure drove it to distress. Silicon Graphics' problems are different. Its capital structure is reasonably solid (its financial leverage is in the normal range for computer-equipment makers, and it has reduced its long-term debt), but its operating results have been going downhill for several years. As the graphical capabilities of personal computers have become more and more powerful, demand for SGI's expensive proprietary workstations has plummeted. Coupled with high research-and-development costs, this has led to a string of operating losses as the company has struggled to reinvent itself.

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